minestie.com

Commodities
Date: February 07, 2006
And Another US$1,000 A Tonne.

By Rob Davies

A few months ago the market got used to the idea of copper at US$4,000 a tonne. Last week copper rose above US$5,000 a tonne and it certainly did not make headline news. Such dramatic moves are typical of a rampant bull market; it’s just that no one in commodity markets can recall the last time the sentiment was so positive. Although there has been a slight fall in copper inventories over the week it would be ambitious to ascribe the US$1,000 gain since October entirely to fundamentals. Indeed, since then inventories of copper in LME registered warehouses have almost doubled. But the fact that the copper market is in backwardation, where forward prices are lower than cash prices strongly suggests that it is being squeezed higher on short-term trading considerations. Whether this is related to the still as yet unresolved Chinese situation remains a mystery. But it could be that others are taking advantage of the distress in the middle kingdom.

With such high metal prices it was a good week for Rio Tinto to announce its record results for 2005. A net profit of US$4,955million is pretty good going in anyone’s books. True, US$2,374million of that was simply due to higher prices, but US$1,140million was due to higher volumes so it has done its bit to help things along. As usual the company takes a low-key approach to the future, confining its observation to saying that the outlook is positive. Even now, China still only accounts for 15 per cent of sales and there is certainly scope for that to grow to at least to the 19 per cent that Japan accounts for, and conceivably a lot more beyond that.

Nevertheless, the company’s actions suggest a more cautious view of the future. While it has increased its dividend, it is only by a miserly four per cent. Shareholders are not being ignored though because it will return US$4 billion to them by a special dividend and share buy-backs. That rather suggests the company thinks these market conditions are rather special too, and might not be maintained. At least the company hasn’t had the embarrassment of suffering losses from its hedging operations like some of its rivals.

For all that we associate big mining companies with the LME traded metals the reality is that the likes of Rio Tinto and BHP Billiton make more money from bulk commodities. In the case of Rio Tinto iron ore accounts for 27 per cent of revenue but 32 per cent of profits, only slightly less than the 37 per cent recorded for copper gold and other by-products. But as that last category includes molybdenum which averaged US$31/lb last year, instead of its more normal price of around US$5/lb, its large share of the pie is perhaps less surprising.

If copper keeps up its current trajectory it could be another US$1,000 higher in a few weeks time and straight line projections could take you anywhere depending on how you draw the line. That would make 2006 a truly bumper year for the likes of Rio Tinto. But sanity will prevail; it’s just that no one quite knows when.